Is Weichai Power (HKG:2338) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Weichai Power Co., Ltd. (HKG:2338) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Weichai Power

What Is Weichai Power's Debt?

The image below, which you can click on for greater detail, shows that Weichai Power had debt of CN¥44.8b at the end of March 2024, a reduction from CN¥47.3b over a year. However, its balance sheet shows it holds CN¥98.2b in cash, so it actually has CN¥53.4b net cash.

A Look At Weichai Power's Liabilities

The latest balance sheet data shows that Weichai Power had liabilities of CN¥147.3b due within a year, and liabilities of CN¥74.7b falling due after that. Offsetting this, it had CN¥98.2b in cash and CN¥60.1b in receivables that were due within 12 months. So its liabilities total CN¥63.8b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Weichai Power has a huge market capitalization of CN¥108.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Weichai Power boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Weichai Power grew its EBIT by 202% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Weichai Power's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Weichai Power has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Weichai Power actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Weichai Power's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥53.4b. The cherry on top was that in converted 107% of that EBIT to free cash flow, bringing in CN¥22b. So we don't think Weichai Power's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Weichai Power .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com